Consequences of the new EU debt-reduction rule

by Gianluca Cafiso and Roberto Cellini

Vox
November 3, 2011

On the back of the Eurozone sovereign-debt crisis, EU countries have agreed on new measures to reduce levels of public debt. This column looks at the fiscal corrections required by some European countries and argues that, if enforced soon, the costs may weigh heavily on the benefits.

In March 2011, the EU countries agreed on the rules for stronger EU economic governance. Debt levels and trajectories will now be a criterion in the assessment of public finances in the context of the Excessive Deficit Procedure (EDP). In particular, “Member States with debt in excess of 60% of GDP must reduce the amount by which their debt exceeds the threshold by at least 1/20th per year over three years. If they do not, they will be placed in EDP” (ECFIN 2011).

If the rule becomes operational in 2011, its application for the period 2011–13 would require the countries with debtabove the 60% Maastricht-limit to reduce their debt/GDP ratio by an average amount of 4.47% (see Table 1 below).The countries with a gap (difference between the current and target level ) above the EU15 average turn out to be Greece (12.4%), Italy (8.8%), Belgium (5.5%), Ireland (5.4%) and Portugal (4.9%).

Conventional reduction of debt is feasible through primary surpluses which erode the debt year after year. Then, it becomes relevant to consider the necessary primary balance, and the linked necessary fiscal adjustment, to achieve the 2013 debt target for the countries exceeding the 60% threshold. The necessary primary balance depends on the interest rate, inflation, and growth scenario which the EU countries will face. We envisage a scenario in which these parameters are set equal to their 1999-2007 average (euro period without crisis). Primary balances to achieve the 2013 debt target are in Table 1. The necessary fiscal adjustment is equal to the difference between the necessary primary balance and the current stance (as defined by the cyclically-adjusted primary balance, Cottarelli et al 2010).

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